Kroger inks Ocado grocery delivery deal to battle Amazon threat

LONDON/LOS ANGELES (Reuters) - U.S. supermarket chain Kroger Co (KR.N) struck a deal with British online grocer Ocado (OCDO.L) to ratchet up its delivery business with the construction of robotically operated warehouses, upping the ante in the battle with Amazon.com Inc (AMZN.O) and sending Ocado shares rocketing.

The U.S. grocery industry is dominated by Walmart Inc (WMT.N) and Kroger but has been in upheaval since last summer, when Amazon’s $13.7 billion deal for Whole Foods sent supermarkets scrambling to match the online retailer on home delivery.

The Kroger deal announced on Thursday is Ocado’s first in the United States and the British company’s fourth major agreement with retailers in six months.

Shares of Ocado, an online grocery retailer known for using robots rather than people to process and pack orders, soared as much as 80 percent to an all-time high. Kroger shares were last up 1.4 percent, with investors reassured by the U.S. company’s saying the move would not dampen expected earnings for 2018 and 2019.

While Cincinnati, Ohio-based Kroger currently offers online grocery delivery service, orders are filled at individual stores and delivery is handled in-house by Kroger and by third-party providers Instacart and Target Corp-owned Shipt (TGT.N).

Kroger’s deal with Ocado, which is exclusive, won plaudits on Wall Street.

“The Ocado partnership is the best investment the Kroger Company’s ever made in the last 25 years,” said Burt Flickinger, managing director of consultancy Strategic Resource Group.

“Ocado is a consumer’s dream and a competitor’s nightmare, and the competitor that’s going to get caught in the crossfire is clearly Amazon,” he said.

U.S. supermarkets fear Amazon will apply its distribution know-how to Whole Foods by transforming existing stores into a grocery delivery network with help from low-cost “gig economy” drivers. Amazon is already offering free two-hour delivery from some U.S. stores for members of its loyalty club Prime.

Yet experts have said that even Amazon, which still operates mostly human-staffed warehouses for its Fresh grocery delivery service, still is figuring out the right model.

“They’re working their path to the customer in two different ways, from very different starting points,” Tom Furphy, former vice president of consumables and AmazonFresh and now CEO of Consumer Equity Partners, said of Kroger and Amazon.

“The most critical consequence of today’s news is the need for other major U.S. players to react,” said Jefferies analyst James Grzinic. “The risk is that today’s news will accelerate that shift, and on less rational terms.”

Britain was one of the first countries to see widespread adoption of online grocery shopping, giving its retailers a head start in developing technology to deal with the challenges of delivering food, especially fresh and frozen goods.

E-commerce accounts for 7.5 percent of sales of packaged consumer goods in Britain, compared with 1.5 percent in the United States, according to data firm Kantar World Panel, which predicts the latter will rise to 8 percent by 2025.

Some analysts and grocers question how well the Ocado model is suited to the U.S. market given its much more dispersed population compared with densely populated Britain.

Outside urban areas, they say that it makes more sense to focus on having people pick groceries from existing stores rather than building expensive high-tech warehouses, or to offer curbside pickup for orders, a service available at Walmart and Kroger.

Kroger executives said the deal is beneficial even if significant U.S. delivery demand fails to materialize.

That’s because Ocado’s warehouses, known as “sheds,” could assemble orders for Kroger’s popular ClickList curbside service, lowering costs and freeing employees to better serve customers, who now tend to bounce between in-store shopping, pickup and delivery.

“This will leapfrog our ability to do that in an accelerated way and in a cost-effective way,” CEO McMullen told Reuters.

Both Amazon and Whole Foods declined comment on the deal.

TRANSFORMING THE INDUSTRY

The deal is a setback for Ahold Delhaize (AD.AS), owner of U.S. chains Food Lion, Stop & Shop and Giant, which some analysts had considered a candidate to merge with Kroger to give the retailer access to Ahold’s U.S. online grocery delivery service Peapod.

Shares in Ocado, which listed in 2010 and delivered its first annual profit in 2014, hit a record of 1,000 pence before closing up 44.4 percent at 804 pence.

Kroger will identify at least 20 sites to build automated warehouses in the United States, Chief Financial Officer Duncan Tatton-Brown said, exceeding all of the centers Ocado has built or is planning to build for all other partnerships.

The two companies are working to identify the first three sites in 2018. McMullen said the first would likely be in an area where Kroger has stores and an opportunity reach new customers.

Ocado “sheds” typically take around two years to open, said McMullen who added that services would be offered under the Kroger name or those of its supermarket chains, such as Ralphs in Southern California.

Tatton-Brown said the partnership has scope in the future to grow two or three times beyond the initial 20 centers.

Slideshow (4 Images)

Kroger has roughly 2,800 stores in 34 mainly Midwest and southern states and offers delivery from 1,100 stores and ClickList pickup at more than 1,000.

The detailed financial terms have yet to be agreed, but Kroger could bring forward some of its payments under the deal, which would reduce Ocado’s need for capital. If the retailer fails to hit volume targets it could also lose exclusivity and will have to pay compensation to Ocado.